Is The Market Plunging Over An Earnings Cliff?

The previous worries of the market seem to be fading away, only to be replaced by a new one that is perhaps more directly meaningful to stock market valuation.

The U.S. economic slowdown of the spring and summer months appears to have bottomed. Home sales, new home starts, and home prices, have all been rising. The employment numbers have improved so much that skeptics even suspect the government must have somehow manipulated the numbers. Retail sales have been picking up. The latest reading of the University of Michigan Consumer Sentiment Index shows consumer confidence is at its highest level since 2007. On Friday it was reported that the U.S. economy (GDP) grew 2.0% in the 3rd quarter, up from 1.3% in the second quarter, and better than the consensus forecast of 1.8%.

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In Europe, the eurozone debt crisis has certainly not been resolved. But the worry has been moving to the back burner on the thought that the EU and ECB have finally put measures in place that can at least kick the crisis further down the road again.

In Asia, China, the world’s second largest economy, has seen its economy slow so dramatically that fears are high that it’s headed for a ‘hard landing’ that would be a further drag on world-wide economies. But recent reports have shown some improvements in China’s retail sales, exports, and factory output.

A remaining big concern is the ‘fiscal cliff’, the automatic expiration of the Bush-era tax cuts at the end of 2012 unless something is done. It’s estimated the impact would take $560 billion out of the economy, cutting GDP by four percentage points in 2013, and put the economy, currently running at only 2% growth, into a recession.

I have contended all along that the fiscal cliff will be resolved, or at least kicked further down the road, but only at the very last moment, which has been the hallmark of how this dysfunctional Congress operates.

I still expect that to happen, and pressure is now on Washington like never before to act responsibly.

The Financial Services Forum, which is comprised of the CEOs of 20 of the largest U.S. financial firms, recently sent a letter to the White House and members of Congress, saying, “At a time when economic growth is less than 2%, and with nearly 25 million Americans either out of work or underemployed, the still-fragile U.S. economy cannot sustain – and the American people do not deserve – the impact of more gridlock in Washington.”

A letter last week signed by 80 CEOs of major U.S. corporations, including G.E., Boeing, Verizon, Aetna, etc., added more pressure, not only urging Congress to get its act together and find a solution to the fiscal cliff, but offering specific initiatives.

These are major financial contributors to politicians, liable to carry more weight than pleas from ordinary Americans.

So there is more hope than before that perhaps even this previous big worry will be taken care of.

Yet, the stock market chooses now as the time to roll over into a potential correction? What’s going on?

The new problem worrying the market is 3rd quarter earnings reports, which show S&P 500 earnings growth turned negative in the 3rd quarter for the first time since 2009, and corporate warnings of similar deterioration in coming quarters.

So we have a market that managed to continue its bull market through worries about slowing global economies, the worsening eurozone crisis, and the looming fiscal cliff, now potentially rolling over due to what some analysts have begun calling the ‘earnings cliff’.

There is reason for the concern. In the final analysis earnings do matter and are the basis for determining the value of a business and its stock. So there is reason to remain cautious and to expect the market still has further work on the downside ahead of it for the short-term.

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I and my subscribers are still in downside positioning in inverse etf’s, and I expect a continuing correction, perhaps significant, as in a double-digit decline.

However, in spite of the new fears of the market plunging over an earnings cliff, I don’t expect the bull market to end just yet.

The 3rd quarter earnings reporting period will end in another week or two. That will give the market some relief from those worries until mid-January when 4th quarter earnings begin to be reported.

I expect positive hints regarding the fiscal cliff will soon begin appearing, and if the improving signs in the U.S. economy continue, the catalyst will be in place for the correction to end, and a favorable season rally to new highs by year-end.

So remain cautious and defensive for now, but remain alert and ready to move in for a potentially substantial and typical favorable season rally.

If I’m wrong and the correction doesn’t end, the current downside positioning will be even more important.